California Income Tax and Residency, Part 1: The Basics

We regularly have consultations with people whose companies are planning to go public or have gone public and are considering leaving California to avoid income tax on their stock options or restricted stock unit gains. A common question has been, “Can I avoid paying tax on the gain by moving to a no-income-tax state like Nevada or Washington?” 

The answer is yes, in theory. But in practice, it is often more complex and highly dependent on an individual’s specific circumstances. 

This article covers the basics of California income tax and residency factors, while Part 2 discusses more specific residency issues and provides some resources so you can review your own situation. This discussion is general in nature and is not intended to address the specific facts or circumstances of any individual taxpayer. 

California Income Tax Basics 

First, let’s touch on the basic structure of California income tax. Residents of California are taxed on their worldwide income, regardless of source. That is, any money you make from anywhere in the world, the state considers taxable income.   

Nonresidents of California are taxed by the state on income from California sources. This is also referred to as a California-source income. Part-year residents are taxed on their worldwide income while they are residents of California, and only on income from California sources while they are nonresidents. 

The Franchise Tax Board, California’s equivalent of the U.S. Internal Revenue Service, says that the purpose of the residency rules is “to ensure that all individuals who are in California for other than a temporary or transitory purpose, enjoying the benefits and protections of the state, should in return contribute to its support.” 

Said another way, if you are living in California and using the services California provides, you should be paying for those services through your taxes. Fair enough. 

Who Is a California Resident? 

A resident is any individual who is: 

1. In California for other than a temporary or transitory purpose, or 
2. Domiciled in California but outside the state for a temporary or transitory purpose. 

A nonresident is simply an individual who is not a resident. 

The underlying theory of residency is that you are a resident of the place where you have the closest connections. This depends on the facts and circumstances of your individual situation. 

Temporary or Transitory Purpose 

If an individual comes to California for a vacation, to complete a transaction, or is simply passing through, the individual’s purpose is temporary or transitory. For example, a digital nomad living the van life and traveling around the country would not be in California for anything other than a temporary or transitory purpose. 

The Franchise Tax Board looks at several factors to determine whether you might be in California for a temporary or transitory purpose. Examples include: 

• Being assigned by an employer to a California office for a long or indefinite period. 

• Returning to California with no specific plans to leave. 

• Being ill and in California for an indefinite recuperation period. 

• Owning real estate in California, sending your children to California schools, holding a California driver’s license or auto registration, or having business interests in California. 

In all these cases, you are probably not in the state for a temporary or transitory purpose, and you are likely a California resident. 

Domicile 

The second part of the definition of resident has to do with domicile. Domicile is “the place in which an individual has voluntarily fixed the habitation of self and family, not for a mere special or limited purpose, but with the present intention of making the permanent home.” This is where you really live. It’s where you consider to be home. 

Franchise Tax Board regulations and a body of case law have defined domicile as “where an individual has his true, fixed, permanent home and principal establishment, and to which place he has, whenever he is absent, the intention of returning.” 

An individual can only have one domicile at a time, and to change domiciles an individual must actually move to a new residence and intend to remain there permanently or indefinitely. 

Residency Audits 

If you decide to move from California to a no-tax or low-tax state immediately before you sell a large amount of stock in a company that has just gone through an IPO or acquisition, be careful. California will look carefully at whether you are actually a resident of California at the time of the sale. The state conducts what are known as residency audits, and they can be very thorough. 

The Franchise Tax Board looks at a variety of factors to determine whether you are a resident of California under the two-part definition above, including: 

• Amount of time you spend in California versus outside the state (home state vs. California) 

• Location of your spouse or partner and children 

• Location of your principal residence 

• State that issued your driver’s license 

• State where your vehicles are registered 

• State where you maintain your professional licenses 

• State where you are registered to vote 

• Location of the banks where you maintain accounts (branches) 

• Origination point of financial transactions (charges on your credit cards) 

• Location of your doctors, dentists, attorneys, and accountants 

• Location of your social ties, such as place of worship, social and country clubs, gyms, and professional associations 

• Location of your real property and investments 

• Permanence of your work assignment in California 

Many people mistakenly believe they can simply fool the Franchise Tax Board by buying a vacation home in Nevada and calling that property their primary residence. Or use a Nevada friend’s address. That isn’t going to work. 

During a residency audit, the Franchise Tax Board looks carefully at where you actually spend most of your time and engage in life. For example, do most of your cellphone calls happen from Nevada, or are they actually still originating from California? Auditors have even been known to review your social media to see where you are when you post. 

When to Change Residency 

The point is: You can’t fake it. In general, an individual must actually move to change residency. And such a move typically needs to be completed sufficiently in advance of receiving the large income influx for which state tax treatment may be relevant. 

These are the basics, which I hope show how much you really need to move out of California to “move out of California.” While residency audits can be rigorous, many taxpayers do successfully establish a change in residency when the move is properly executed and supported by the relevant facts and documentation. 

In the next post, we’ll look at some additional considerations, such as how this all ties into equity compensation and how residency laws interpret this growing trend of remote work.Top of FormBottom of Form 

Savant Wealth Management provides holistic wealth management services including financial planning, equity compensation planning, investment management, tax planning, and others, on a fee-only basis and as a fiduciary, acting in clients’ best interests when providing investment advisory services. If you’d like to explore how we can help you build and protect your wealth, schedule a complimentary consultation to discuss your circumstances and learn more about our services. 

This is intended for informational purposes only. You should not assume that any discussion or information contained in this document serves as the receipt of, or as a substitute for, personalized investment or tax advice from Savant. Please consult your investment or tax professional regarding your unique situation.